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If you’re looking to grow your business with a loan, you can use unsecured or secured business loans. Secured loans are backed by collateral, such as a valuable asset, while an unsecured loan isn’t.
Because secured business loans require collateral, there can be more steps to acquiring one. However, it can make sense if you can qualify for more favorable terms than you would with an unsecured loan.
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What Is a Secured Business Loan?
A secured business loan is a type of business loan that’s backed by collateral. Collateral can be various business assets, such as real estate, equipment, inventory or investments. The lender uses the collateral to guarantee repayment of the loan. If you default on your secured business loan, the lender can seize your assets as a form of repayment.
The collateral reduces risk for lenders and, in turn, can mean lower interest rates and higher loan amounts than what you may be offered on an unsecured business loan. Secured loans, however, are more risky for you, the borrower, because you could lose your business assets if you default.
Secured business loans are typically term loans that you repay monthly over a certain number of months or years. It may also be possible to obtain a secured business line of credit, which is similarly backed by collateral but lets you withdraw funds as needed.
How Does a Secured Business Loan Work?
Secured business loans offer financing that you can use to purchase equipment, pay your employees or cover other business-related expenses. These loans are distributed in a lump sum, meaning you’ll receive the full loan amount once you accept the loan.
You’ll then repay the loan over a predetermined term outlined in the loan agreement. Typically, you’ll make regular payments on a monthly basis, but that can vary depending on your lender.
Your secured business loan may be backed by collateral you already own or an asset you plan to purchase. Some common types of collateral include:
- Cash savings
- Real estate
The lender will evaluate the value of your collateral as well as your business’s financial information to determine your eligibility. The lender can consider your personal and business credit score, annual revenue, business plan, industry, among other factors when evaluating your application.
In some cases, the lender may ask for a blanket lien, which allows them to seize any of your business assets if you default. Some lenders also request a personal guarantee, which obligates you to pay back the loan with your personal funds if your business’s assets can’t cover the full amount.
Pros and Cons of Secured Business Loans
Before applying for a secured small business loan, consider both the pros and cons of this loan type.
- May have less stringent qualification requirements. Since it’s backed by collateral, secured business loans may be easier to qualify for, including lower credit score and revenue requirements.
- Could come with better interest rates. Lenders may offer more favorable terms, such as lower interest rates or longer repayment terms, on secured loans than unsecured ones.
- Higher loan amounts may be available. You may also qualify for a larger loan amount with a secured business loan than you would with an unsecured one.
- Your business assets are at risk. The danger of a secured business loan is that you could lose your collateral if you can’t repay your loan. The lender can seize your asset as a way to recoup its losses.
- Application process may take longer. It may take longer to get a secured business loan because your lender may require an appraisal of your collateral to determine its current market value.
- Could come with fees. Some secured business loans come with origination fees, among other fees, which could add to your costs of borrowing.
How To Get a Secured Business Loan
The process for getting a secured small business loan will vary by lender, but you’ll generally take these steps:
- Determine your loan amount and purpose. Consider how much you need to borrow and what you’ll use the loan for, as this will help you narrow down your list of lenders and determine what asset you’ll use to back the loan. Equipment loans and real estate loans are backed by the equipment or real estate you plan to purchase, for instance.
- Check your credit. Although the credit requirements for secured small business loans may not be as stringent as they are for unsecured business loans, lenders still consider your credit. Familiarize yourself with your credit score and profile before you start applying for loans.
- Compare lenders. Research various types of lenders, including banks, credit unions and online lenders, to find ones that offer the right type of financing to meet your business needs. Consider each lender’s interest rates, loan amounts and repayment terms, as well as their credit score, annual revenue and time in business requirements.
- Gather your documentation. To apply for a business loan, you’ll be required to provide documentation, such as bank statements, tax returns, business licenses and other legal documents. You’ll also need to provide details about the collateral you’ll use to back up the loan.
- Submit your loan application. Your final step is to submit a formal loan application, which asks for personal and business details, as well as supporting documentation.
After submitting your application, the lender will review your information and determine your loan approval. It may also order an independent appraisal of your collateral to ensure that its value is sufficient to back up the loan.
Finally, the lender may file a UCC lien with your secretary of state, which gives the lender authority to seize some or all of your business assets if you default on the loan. This lien will expire after you pay back your small business loan in full.
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